Tuesday, June 25, 2013

Kress cycle deflation pressure increases

To
many observers, deflation was a thing of the past in the wake of the QE3. The Fed’s asset purchases, which drove down
bond yields to record lows, were thought to have tamed the global deflationary
problem once and for all. What they
didn’t count on was the floodtide of deflation breaking through the dikes and
barriers carefully constructed by the world’s central banks.

The
increasing deflationary pressure is most visible in Europe and Asia but will
soon wash up on U.S. shores in the near future.
A general deflationary trend is already visible in equity markets in
several major countries, a consequence of the final descent of the 120-year
Kress cycle. As that cycle approaches
its final bottom in late 2014 we can expect to see an increase in some of the
problems we’re just starting to see right now in the global economy.

One
of the most conspicuous victims of the deflationary Kress cycle is China. China has in fact led the recent malaise in
global markets starting with an 11% surge in short-term interest rates in
China. China’s overnight repo rate
increased by an incredible 25%. As
analyst Bert Dohmen commented, “China is extremely important for all business
leaders and investors….Because whatever happens to China will tremendously influence
the world economy and your investments.
Many large U.S. and European companies depend on China for a significant
portion of their sales and profits….A crisis in China will have global
repercussions.”

China’s Shanghai Composite Index has
been in a bear market since peaking in mid-2009. It’s remarkable when you consider that as the
rest of the world has experienced a measure of recovery for the last four
years, China’s stock market has been in decline. In fact the Shanghia index is on the verge of
testing its 2008 credit crisis lows, as you can see here.

One of the most fundamental pillars
of market analysis is that the stock market always predicts future business
conditions. What is this telling us
about China’s business and economic future?
The message can’t be interpreted as anything but negative for the
nations of the world that depend on China’s manufacturing sector.

Then there is Russia. Not that Russia is of any great importance to
the global economy by itself, but Russia has long been a benchmark for
deflationary pressures. Since much of
Russia’s economy is tied to oil and natural resources, any sustained decline in
the price of oil will automatically exert a negative impact on the country. Remember back in 1998 when oil prices
collapsed to $10/barrel? Russia’s
financial sector went into collapse and its economy was in shambles. It took an oil price recovery in the last
decade to allow Russia’s economy to bounce back and grow for nine straight
years. Without the artificial oil price
inflation, thanks in large part to the Fed and other central banks, Kress cycle
deflationary forces would have long since wiped out Russia.

Here’s what the Market Vectors
Russia ETF (RSX) looks like over the last four years. Note the bear market pattern visible in this
chart since 2011. Any further decrease
in the price (and demand for) oil won’t bode well for Russia and will only
hasten the country’s economic demise.

What about the other BRIC
countries? India’s stock market is
currently probing a 4-year low and the country’s debt market had to be shut
recently as yields increased beyond trading bands. Brazil, which was the rising star of the
emerging markets not long ago, is slowing economically and has been described
recently as “dysfunctional.” Not
surprisingly, the natives are growing restless.
As Reuters reported on June 24, “More than a million Brazilians have taken to the
streets this past week in the largest mass demonstrations since the impeachment
of President Fernando Collor de Mello in 1992.”

Brazil’s stock market, as reflected in the MSCI
Brazil Capped Index Fund (EWZ), has broken down from a bearish triangle pattern
– a pattern much similar to the one visible in the Russia ETF shown above. This could be a preview of what’s to come for
other emerging markets in the not-too-distant future as we draw closer to the
120-year cycle bottom.